Real Estate Investing – Objectivity – And Jumpin’ Out Of Airplanes

In the many conversations I have with experienced real estate investors and those wantin’ to get started, the subject of strategy is virtually sure to come up. Leverage, assumptions used in analysis, where to invest, financing decisions and the like, become pieces in your own personal game of Monopoly. Once finding themselves honest to goodness real time, real life players? They tend to stop viewing it as a game. Go figure.

The laws of physics, gravity for example, work every time they’re tried. For good, bad, or indifferent, gravity will never cause you to fall up. Air travel is soundly based upon the laws of physics, which is why you and I don’t give it a second thought when we get into a multi-ton tube with wings in order to fly a couple thousand miles in but a few hours. Why do we trust it so much?

The laws of physics will not be mocked. We know the jet in which we’re playing poker on our laptops, bored, was built upon that principle. The same goes for real estate investing. The problem arises when subjectivity must sometimes be inserted into any particular equation.

Subjectivity? Aren’t all investment decisions held hostage, at least in part, by the literal compulsion to include subjective judgment? Yeah, pretty much. On the other hand, opting for subjective over objective analysis of location, for example, is why so many investors are in a world of hurt.

Grandpa said never invest in property you can’t drive by at will. In his day, acquiring property 1,000 miles from home wasn’t on the regular guy’s menu. Today? It’s on virtually everyone’s menu. Those insisting upon staying close to home, when other regions are easily shown as superior, are catering to an emotional need — not an objective conclusion based upon sober analysis. This isn’t to say sometimes objective analysis won’t point to home as the best place to be. It’s a school of thought. I belong to the school that teaches us to go with what our research and analysis reveal to us. What a concept, eh?

Simply put, if your local market offers a fourplex for $500,000, with an Gross Scheduled Income (GSI) of $42,000, yet 1,500 miles away lies a physically superior fourplex in an obviously higher quality location for $390,000, sportin’ a GSI of $52,500 — your decision to stay local was one based upon emotions. Many become irate when I say things like that, but when pressed to supply objective reasons for their stated preference, they do excellent imitations of trees. They’d rather reap relatively much poorer results than not be able to drive by their empires.

Get over your local market before it gets over on you.

The rationalizations of investors in love with their obviously inferior local markets provide material for my speaking engagements. I can have some fun with them, cuz I used to be them. Boiled down to its bottom line essence, the numbers tend to turn the ‘DriveBy’ crowd, as I call them, into crickets.

Here’s a very recent conversation had with a west coast investor. The above mentioned fourplex was a couple miles from his home. He liked the area, and as he said, ‘the numbers made sense’. Let’s look at his property vs the one I proposed.

30% down payment at 5.75%/30 yr. fixed results in a break even.

In a region far away — or as I put it to him, a mere 1,437 mile drive — the other fourplex mentioned above required:

25% down payment — at 5.75%/30 yr. fixed, there resulted a cash on cash return of 9.5% — about $900 monthly.

Won’t bore you with all the ways the latter property is superior. Suffice to say, the potential results in five years for the far away units are not only staggeringly better, but embarrassingly so. Still, the investor refused to entertain the possibility that it might be worth it to consider anything outside his 10 mile diameter of comfort, regardless of the qualitative increase to his ultimate retirement income. To each their own, it’s their cash. I get it.

Meanwhile, back at RealityRanch, those who keep the subjectivity to a bare minimum, not tempting the physics of economics, will do much mo betta than those insisting on obeying subjective needs — more honestly described as emotional needs. The laws of economic physics, like those of the physical universe, work regardless of who’s using them — or abusing them. They’ll supply excellent or massively destructive results with equal apathy and efficiency.

Emotions, ego satisfaction, or the need to drive by and admire your empire, don’t change the results of the laws you put in motion. Jump out of an airplane at 10,000 feet with a parachute and the requisite skill, and your experience will be exhilaratingly enjoyable. Doing the same sans parachute will have a decidedly different, um, impact. Same gravity at work in both scenarios.

View the landing in both cases as your retirement.

NOTE: I fully realize staying in your local market will, in most cases, not end up the same way a skydiver will without his chute. You get the point though, right?

The lesson here is to adhere to the laws of economics with the understanding that they work every time, for good or ill, regardless of intent. Those insisting on remaining in their own market in order to feed a completely subjective need, should never be surprised when those who don’t, enjoy vastly superior results in retirement.

In other words — don’t jump out of the plane without a parachute expecting a soft landing. Gravity doesn’t understand subjectivity.

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19 Comments

Jeff
I couldn’t have said it better myself. When people get off their “local” bandwagon, the world presents a much rosier picture. To get $1,000 rent from something in Orange County, CA, you need to buy an approximate $300,000 house. To get $1,000 rent from something, say in Dallas or Tulsa, you need to buy an approximate $100,000 house. To get $1,000 rent from something, say in Memphis or Detroit, you would buy something around $50,000.

I hear people say they SAVE money having it local. So let’s say you save 8% of the rent in Orange County. It cost you $200,000 – $250,000 to save $80.00 a month. It doesn’t take an Einstein to figure out that you aren’t really saving anything!

Exactly Mike — The logic/rationale of the DriveBy crowd reminds me of those who’d rather burn a buck in gas to pay half a buck less for a fill-up. 🙂

In San Diego they’ll pay $350K for a 55 year old duplex with a GSI of less than $28K, while ignoring a brand new duplex outa state with a $30.6K GSI for just $250K. Debate with that mindset is almost always futile.

Jeff, another thought I had is who is going to manage your property? If you own 50 properties, this might work, but if this is your first project, you can’t possibly afford to hire a management company. I could be wrong though.

Hey Jeffrey — It’s one of the myths of real estate investing, that the regular guy investor can’t afford pro management. I’ve been proving that wrong with my clientele since Carter was in office. Not only can they afford it, but they’d be foolish not to have it, AND they still enjoy cash flow.

So don’t even allow that myth to be a factor in your thinking. In fact, I’ll go a step further. If your property can’t afford management, you may wanna reconsider it’s acquisition. Remember — the long term goal is retirement income — NOT income now. The few dollars given up for pro management now, pays off in spades when it’s time to retire. Those who fall in love with cash flow when capital growth is the ‘current’ primary goal, pay a wicked price.

Property management is just a cost of doing business. Some folks like Steve Dexter have excelled at long range investing without a PM. For the rest of us, we calculate the PM cost when evaluating a deal. I fully believe a savvy investor can have their cake and eat it too. A positive cashflow property with a pm in a good market for growth. I know its possible because folks on this board do it every day. Heck even an non-savvy investor like me manages $150/month average positive cashflow with a PM. (assuming 15% maintenance, 8% vacancy, 14% PM fees, mortgage plus taxes and insurance at 40-50%)

I have been one of those who have always had issues with PMs. As the saying goes… I always take better care of my investments then others would.

Yet, with that being said, many investors can’t be in a position to manage their properties because they must look outside their local area to get the best returns… and if they aren’t seeking the best returns… one has to wonder what their business model is.

Bottom line… the prefered skill set needed in this situation is the ability to find and manage effective PMs.

Jeff,
If all we are looking at is estimated cash on cash return then you “may” have a point.
But, as a Certified General Appraiser and investor since the early eighties, I’m afraid I must disagree. Too thin… There’s many a slip twinst the cup and the lip. Too general, it’s cash flow and appreciation over the the entire hold of that asset. Not to mention the fact that our priorities in “real life” change over time, depending on, you name it. ” Estimated cashflow, or cash on cash returns as you present them ignore a host of realities that investors must deal with which many times render professionally managed properties profitless; that is except for the property management companies and their underlings. I will admit, easy subject to make look simple in writing, not so in real life. Thanks you for the article.

When u look at investing in different states, try to find states within driving distance. We like properties within 7 hours driving distance so we can easily get there in a pinch. Also, consider properties that r newer and don’t need as much rehab and future repairs. Property management is everything when it comes to investing outside your own city.

I agree completely with, — “If all we are looking at is estimated cash on cash return then you “may” have a point.” However, I don’t do that. Any property numbers I may use in posts are actual properties, with real life numbers.

I also strongly agree with you when it comes to, “. . . it’s cash flow and appreciation over the the entire hold of that asset. Not to mention the fact that our priorities in “real life” change over time, depending on, you name it.”

Those two axiomatic statements don’t obviate the central theme of the piece, which is that subjectivity, and emotional bias towards local markets can and many times are the reason investors don’t do nearly as well as they could, or fail altogether.

As an appraiser you were objective. If the folks you and I talk with applied the objective principles in which you and I both believe, they’d be better off. I know you agree.

Anything I ever talk about, especially numbers, analysis, etc., is never a result of some lame estimation.

Hey McKellar — I’m not one of those who’d subscribe to your ‘long distance’ drive-by approach, but I can certainly see where it would work well, assuming the property(s) were superior. Frankly, if the average investor puts, say, $170,000 in cash/equity into three smallish income properties, and has stellar prop management, flying there every now and again wouldn’t be a problem.

Still, your M.O. sounds pretty dang good when coupled with your stated parameters. I like it — if it’s possible, distance wise.

Hi Jeff- Investing in Antarctica would be ok if the cash flow was there and you could find evidence of future appreciation. For “fly bys,” you should build in ample travel expenses and then multiple by 2 for the first year. After stabilizing the property, you don’t have to be as involved. I rarely drive by my properties in my hometown after the first year. Not sure if I should admit that.

Traditional investing works slow and is difficult to do. That’s why investing in real estate has always been one of the best wealth-building strategies on the planet. The key is to stay ahead of the market and be flexible.